F5 CEO Locoh-Donou Charts the Software Shift

The Street today was digesting what it heard yesterday from F5 Networks’s (FFIV) chief executive Francois Locoh-Donou at the company’s annual analyst day meeting in New York.

Locoh-Donou was kind enough to stop by Barron’s offices yesterday, following the presentation, to chat with me a bit about what it all means.

This was his first analyst meeting since he took over the job in April of last year from longtime CEO John McAdam. Locoh-Donou, who grew up in the African republic of Togo, and was educated in France, previously worked for several years at fiber-optic networking star Ciena (CIEN), starting in 1997. He embraces his new home in F5’s Seattle environs, lauding the city for a "very strong human, philanthropic vibe,” adding "I resonate with the values there."

As for the meeting, “My main objective was to lay out our strategy, to have people understand the trajectory we are on for the next five years, where we are investing, and to see that it's a growth trajectory,” he told me.

The highlight of Thursday's analyst meeting was the company’s offering financial targets for multiple periods. Not only did F5 pledge revenue growth this year of 2.5% to 3.5%, it also said it is expecting growth in 2019 and 2020 of “low-to-mid single digits,” and in 2021 through 2022, revenue growth of "mid-to-high single-digits."

Reaction has been mixed. F5 shares today fell by 4% yesterday, though closed up 42 cents today at $147.48.

Reviewing the day, Cowen & Co.’s Paul Silverstein, who has an Outperform on the stock, and a $162 price target, is upbeat, writing that its "operating model" is "more resilient” and the company is "better positioned relative to shifting enterprise IT architecture than most investors appear to believe."

But there is also a good deal of skepticism. Simon Leopold of Raymond James, who has a Market Perform rating, writes that the “ship is pointed in the right direction, but that “the tansformation may take time."

The software switch

The transformation, in this case, is the move to being more and more of a software company. The company’s product, the “application deployment controller,” or ADC, which has been a mainstay of networked apps for years, is shifting to “virtualized” models that are software programs that can run on commodity hardware.

Today, software is just 15% of revenue, but it is seeing “very significant growth,” says Locoh-Donou, on the order of 30%. That shift to software, and also operating “efficiencies” that F5 is undertaking, things like streaming its own tech use internally, are going to help margins and thereby boost profit faster than revenue grows, he told me.

He conceded, however, “It’s not something that happens overnight."

I asked Locoh-Donou if he’s factored into his outlook a hit to revenue as deferral of subscription revenue takes place, as has happened with other companies that made this kind of “model shift."

"That won't be as challenging for us as subscriptions just launched and so it’s not yet material,” he said.

Cloud catalyst

The company has competition from Citrix Systems (CTXS) in the software market, though he seems confident the breadth of F5’s software will put it ahead of that company. Deals with Amazon (AMZN) and Microsoft (MSFT) and Alphabet’s (GOOGL) Google in their respective cloud businesses are serving as a sales channel for the software, and he hopes to work with other cloud providers. He likes how that can potentially accelerate sales.

"Cloud is a catalyst for us: it enables more applications to be deployed faster, and they get replicated across availability zones, and every time they do, that's more instances of F5."

He notes too that the "attach rate” for security technology for those software ADCs is "in the public cloud is twice what it is on-premise."

The cloud giants "have a basic load-balancer,” he says, “only the most basic functions of server pooling, and such,” so he’s not worried about those partners becoming serious competition.

“All the stuff that our customers value, like application firewall, and DNS management — all that stuff on the left, they don't do that."

Thinking outside the VM

I asked Locoh-Donou about the rise of containers and serverless, or functional, computing. He’s positive on all those things.

"Serverless and containers are great,” he said. “They speed up development, and make things easier to distribute. But that also raises new complexities, and that's good for us,” given there’s a need to tools to manage the complexity. “In fact, our next generation of our software that we are building will be containerized. Customers will be able to combine it in a container as a part of their app."

Hardware still happens

The other 85% of revenue, the hardware part, is not going away overnight, he says. “The hardware market is durable. I don't have a crystal ball, but we think it’s either flat or declining by low single digits” for several years to come. The big reason is large enterprises and service providers cannot simply dump their habit of buying hardware, and switch to buying software. It takes them much longer to make that move, he notes.

M&A philosophy

I asked him why F5 doesn’t acquire more broadly, to make the portfolio more extensive, as Cisco Systems (CSCO) over the years broadened its reach.

"We have a growth strategy, and acquisitions are part of that,” he said. “But, look: it's easy to buy companies, but hard to do it in a very disciplined way."

"For us, we don't rule it out. We want to have a clear reason to do an acquisition. We are on course to offer multi-cloud application services of all kinds, and to reach every app, everywhere. Anything that would de-risk or accelerate that plan, including acquisitions, is something we’ll consider."

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